By Spencer Jakab
Should you buy the biggest, nicest house on the block or a
fixer-upper? In the case of home-improvement retailers Home Depot
Inc. and Lowe's Cos., the answer may be neither.
Both have had an impressive run during the economic recovery,
especially in terms of profits and margins. But their share prices
have become untethered from the rebound in home sales and
construction.
Home Depot, the larger and more profitable of the two companies,
has beaten a basket of home builders such as Lennar Corp. and KB
Home by 205 percentage points over the past five years, including
dividends. Lowe's has outperformed by 145 points.
The news from both retailers should be good when they report
this week. On Tuesday, Home Depot is seen posting earnings for the
fiscal fourth quarter ended in January of 89 cents a share, up from
73 cents a year before, according to FactSet. Lowe's is seen
reporting 44 cents for the same period, up from 29 cents a year
earlier.
Both retailers are upbeat about further improvement in the
housing and consumer-spending recoveries, probably with good
reason. Home Depot points out that private, fixed residential
investment as a share of gross domestic product has yet to recover
to its long-run trend, and management expects home-improvement
spending to increase one to two percentage points faster than GDP.
Comparable sales for the company rose about 4.6% last fiscal year,
based on a recent update, while Lowe's increased between 3.5% and
4%.
Home Depot looks slightly better on other measures, too. For
example, it is targeting an operating margin of 13% and return on
invested capital of 27% this year. Lowe's, on the other hand, hopes
to hit 11% and 19%, respectively, two years from now.
Unsurprisingly, Home Depot fetches a slight premium on some
trailing valuation measures. But the more salient point is that
both are pricey at 21 to 22 times forecast earnings for the next 12
months. For Lowe's and Home Depot, that is a 25% and 37% premium,
respectively, to what they commanded a decade ago in the middle of
the housing bubble.
The sector has improved so much that it has begun to price
itself out of the market.
Write to Spencer Jakab at spencer.jakab@wsj.com
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